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Everyone has a lot to digest in the wake of Donald Trump’s presidential victory, but for markets one question looms large: What should it change in the policies of the world’s most powerful central bank, the U.S. Federal Reserve? The answer differs depending on whether you’re looking at the next few months or the next several years.
In the near term, the Fed (and probably other central banks) will perceive Trump’s election as a new source of uncertainty. His platform contains a lot of standard Republican fare such as lowering taxes and reducing regulation —measures that, while they might not be as great for growth as Trump hopes, present no immediate economic threat. Much less conventional, though, is his view that trade has hurt America. This idea stands in exact opposition to the development of the global economic order since the end of World War II, and generates immense uncertainty surrounding how it will translate into policy, how the rest of the world will respond and what the effect on global growth will be.
Such uncertainty tends to chill economic activity, as multinational businesses wait to see how events unfold. The Fed will want to counteract that headwind by easing monetary policy. For that reason, I think it’s highly unlikely that the central bank will increase interest rates at its next policy making meeting in December (and I would actually favor a pre-emptive rate cut). What happens in the first half of 2017 depends on the details of Trump’s trade policies and the global reaction, but I can imagine many scenarios in which the Fed would want to keep rates steady throughout that period, or even take them lower. The medium term — that is, next
three to four years — looks quite
different.
Trump has argued in favor of cutting taxes and increasing various forms of spending. In his acceptance speech, for example, he committed to rebuilding American infrastructure so that it is “second to none.” Such policies would add considerably to the national debt: The non-partisan Committee for a Responsible Federal Budget estimates that under Trump’s economic agenda, U.S. government debt held by the public would reach about 150 percent of gross domestic product by 2036, nearly double the current ratio.
If Congress went along with Trump’s initiatives, the increase in debt and spending could be very helpful to monetary policymakers, here and in other countries. Right now, many central banks — including the Fed — are struggling to achieve their inflation and employment goals, even though they have already taken interest rates down to zero (or even lower). That’s because the “natural” real interest rate — that is, the rate consistent with full employment and stable prices — has fallen sharply over the past few years.
Increasing debt and spending would likely stimulate growth and boost the government’s borrowing costs, pushing up on the natural real rate of
interest.
This would enable central banks to maintain higher rates while still hitting their inflation and employment targets, giving them more ammunition to fight future recessions. In this way, Trump’s economic plans could help reduce a key source of economic uncertainty for the globe.
—Bloomberg
Narayana Kocherlakota is a Bloomberg View columnist. He is a professor of economics at the University of Rochester and was president of the Federal Reserve Bank of Minneapolis from 2009 to 2015